International
Accounting Standards Board Chairman Sir David Tweedie on Tuesday
outlined a possible approach for reconciling the divergent IASB
and FASB models for financial instruments accounting.

With
FASB’s comprehensive exposure draft on financial instruments
expected any day, Tweedie said during a JofA exclusive
interview at the AICPA Council meeting in San Diego that public
comments on the boards’ proposals will play a key role in getting
their two approaches closer together.

Speaking
later to the AICPA Governing Council, Tweedie thanked the AICPA
for its longstanding support of the IASB even before international
standards were popular.

To
understand Tweedie’s approach to fixing the financial instruments
problem requires some background on where the standards setters
diverged. As a result of the subprime mortgage collapse,
accounting for loans and securities derived from loans was widely
criticized. When the financial crisis started in 2008, this
project was already on the active agendas of both standard
setters, but the crisis put enormous political pressure on the
IASB and FASB to improve their standards as soon as
possible.

In
a move that was not followed by FASB, the IASB split its project
to replace IAS 39, Financial Instruments: Recognition and
Measurement, into three parts to deal separately with
classification and measurement; impairment; and hedging. FASB
decided to deal with all three aspects of financial instruments in
a single project and plans to issue its comprehensive exposure
draft by the end of this month.

Despite
intense joint deliberations, FASB and the IASB were unable to
agree on a common approach for classification and measurement. The
IASB published its approach on Nov. 12, 2009, with the release of
IFRS 9, Financial Instruments. IFRS 9 may be adopted early
but is not effective until Jan. 1, 2013.

Under
what is expected to be the proposed FASB model:

Most
instruments would be measured on the statement of financial
position at fair value with changes in fair value reflected in
net income, or net income and other comprehensive
income;

A
limited amortized cost option would be available for financial
liabilities; and

No
reclassification would be permitted between
categories.

Under
the IASB model (IFRS 9):

The
scope of the standard is limited to assets only;

Amortized
cost is used when it matches the entity’s business model and
cash flow characteristics of the asset;

Fair
value is used for equity instruments, most derivatives and
some hybrid instruments; and

Bifurcation
of embedded derivatives is not
permitted.

Asked
directly whether the boards will be able to reach a compromise on
their approaches, Tweedie said the divergent approaches were
caused by mismatched timing between the boards’ work and the
inherent problem of having two major standard setters rather than
one. To get back on track, he said, the two boards will sit down
together this fall following review of constituent feedback on
both boards’ proposals.

“Say we
both stick to our same positions [on classification and
measurement], maybe we need to put out something that would say
‘if you want to get the same other comprehensive income as FASB,
you have to add this on, which would be the fair value’” he said.
“FASB would do the opposite. If you want to get the FRS number,
you deduct this. There are ways to do it.”

On
the remaining pieces of the IASB’s financial instruments project,
Tweedie explained that basically they plan to let the constituents
decide which is the best model. The IASB published its exposure
draft dealing with impairment on Nov. 5, 2009, with comments due
July 5, 2010. The IASB plans to publish a request for views on
FASB’s model when FASB publishes its ED. The boards plan to
jointly consider the comments received on respective proposed
models. They will also discuss feedback received from an expert
advisory panel that has been established to advise the boards on
operational issues on the application of their credit impairment
models and how those issues might be resolved.

A
credit impairment would be recognized when information is
available indicating that there is an adverse change in the
expected future cash flows of the financial
asset;

An
entity must consider all available information on past events
and existing conditions but not future scenarios;
and

Creditors
would not be prevented from evaluating losses on a pool or
portfolio basis.

The
IASB published on Nov. 5, 2009, a proposed impairment model for
those financial assets measured at amortized cost. The model uses
expected cash flows.

The
proposed IASB model requires an entity:

To
determine the expected credit losses on a financial asset when
that asset is first obtained;

To
recognize contractual interest revenue, less the initial
expected credit losses, over the life of the
instrument;

To
build up a provision over the life of the instrument for the
expected credit losses; and

To
reassess the expected credit loss each period and to recognize
immediately the effects of any changes in credit loss
expectations.

The
IASB plans to publish an ED on hedging, the third part of its
financial instruments project, to coordinate with publication of
FASB’s ED. “I would think if FASB thinks ours is better, they’ll
move toward that; if they think, ‘no that’s gone too far,’ we’ll
come back to where FASB was,” Tweedie said.

The
key, according to Tweedie, is that “both of us are asking the
others’ constituents to look at the opposite model. So this fall,
we can say the world in balance thinks this is the best approach.”

For
those concerned about the number of exposure drafts the boards
plan to publish in coming months, Tweedie said the boards met last
week and discussed issuing no more than three or at the most four
major EDs at a time. This would likely require the boards to
rework their schedules
for the 11 projects the boards reconfirmed last fall from their
2006 Memorandum of Understanding (see Countdown
to Convergence, JofA, March 2010).

“We’re
looking at what’s really essential,” he said.

When
asked about what could be holding the SEC back in making a
decision on IFRS, Tweedie said he doesn’t think “the U.S. is
really stuck on the fence,” but that the SEC will come through
with a plan next year.

For
Tweedie, who is starting his last year at the helm of the IASB,
bringing U.S. GAAP and IFRS as close together as possible is his
top priority. “The world needs the U.S. to be involved in standard
setting,” he said.